Making Sense Of The Tax-To-GDP Ratio Debate

Pakistan is one of the most heavily taxed countries in the region. Unfortunately, the burden of taxation disproportionately lies on the poor, who pay indirect taxes that fund the obnoxious perks and luxuries enjoyed by the civil-military ruling elite.

Making Sense Of The Tax-To-GDP Ratio Debate

Pakistan’s capacity to mobilize taxes is greatly under-explored. With a tax to GDP ratio of 8.5%, along with an undeclared economy almost the size of official economy, the potential of tax collection is astronomical. With an estimated total economy twice the size of Rs1,000 trillion official economy at a modest tax collection of 16% puts a revenue of Rs32,000 billion in sight…— Haroon Khawaja, Lost FBR hits a dead end

There has been persistent pressure on successive Pakistani governments by policymakers, especially those affiliated with multilateral donor agencies, to increase the percentage Tax-to-GDP ratio. It is true, that the fiscal deficit continues to increase. However, the assumption that it is a tax shortfall that grows the deficit needs to be challengedNadeem Ul Haque & Raja Rafi Ullah, The Odd Fascination with Tax-to-GDP Ratio (PIDE Knowledge Brief No. 78:2022)

Special Investment Facilitation Council (SIFC) has finalized a digitization and restructuring plan of the Federal Board of Revenue (FBR) for the approval of the incoming federal government…These restructuring measures will play an important role in removing obstacles to tax collection and improving the efficiency of the tax machinery. The use of modern digital technology will help in broadening the tax base and compliance with the tax policy. Tax revenue collection will be increased to 18 percent of GDP by 2029 from the current level of 8.5 percentPress release at the website of Ministry of Information & Broadcasting 

“If we want lower taxes for growth, then spending must be curtailed so that governments won’t need so much money. The next time you hear a politician promise another tax break for some special group of taxpayers, think how much that hurts the economy and you as a taxpayer. It’s time to simplify the system and reduce its onerous impact that undermines economic growth” Jack M. Mintz, the Palmer Chair of Public Policy, School of Public Policy, University of Calgary, Canada

The debate over the tax-to-GDP ratio in Pakistan has always been lopsided, failing to take into account the fact that the Pakistani nation remains the most heavily taxed in the entire region. Adding insult to injury, the citizens in return even do not get clean drinking water, free health and education, what to speak of social protections like universal pension for all, out of taxes paid over the period of time.

In federal tax collection by the FBR, there has been an overwhelming reliance on indirect taxation, even under the garb of direct income taxation through presumptive and minimum tax regimes on a number of transactions, without evaluating its impact on the economy and life of the less privileged sections of society. This flawed tax policy has been contributing towards the rich-poor divide by exacerbating inequality, as well expanding inequalities in income and wealth distribution.

In the face of declining income tax contribution (after excluding indirect ones levied under Income Tax Ordinance, 2001), the finance ministers of successive regimes—civil and military alike—and Revenuecracy have been making tall claims about “impressive” increase in taxes before the International Monetary Fund (IMF) and elsewhere. The reality of this “impressive” performance has been exposed in various columns by this scribe.

However, the IMF and World Bank in the past kept mum, as they were party to portraying all-good “projection saga” during the era they Uncle Sam needed Pakistan; first for dismemberment of USSR and later for imposing New World Order in the name of the ‘War on Terror.’

Back in 1995, the then Prime Minister Mian Muhammad Nawaz Sharif claimed during a meeting, held in Washington on October 21, 2015, with that time Managing Director of IMF, Ms. Christine Lagarde, “We have achieved the highest tax-to-GDP ratio and Pakistan’s economy has been stabilizing due to prudent policies of my government”. This claim was diametrically opposite to what was stated by the then Auditor General of Pakistan (AGP) in his report making “astonishing disclosure” that the tax-to GDP ratio of FBR “reached its lowest level on the conclusion of the World Bank funded Tax Administration Reform Project (TARP).”

An unholy anti-people trio of the indomitable militro-judicial-civil complex, inefficient politicians and greedy businessmen—control and continue to enjoy at least 90% of the state’s resources, all while they contribute less than 1% towards national revenue collection.  

It was strange that in the presence of report of AGP, our Prime Minister, his Finance Minister, and other “financial experts” were trying to convince the IMF that “all is well.” Now they are back to in power, but this time, we all know, it would not be possible to hoodwink the IMF.

Nawaz Sharif, on assuming government for the third time as prime minister, gave unprecedented tax waivers and concessions to the non-filers and tax evaders—even then, his amnesty schemes miserably failed. It could only yield Rs. 1.3 billion!

In these columns, efforts have been made to explain reasons for the poor tax collection. However, citizens for the last few decades rightly raise the question of  how rulers play havoc with taxpayer funds. We must calculate the cost to the national exchequer in providing tax-free perquisites and benefits to the indomitable militro-judicial-civil-complex and public office holders in the form of palatial residences, armies of servants, expensive cars, golf courses, rest houses etc. They call on first ending this colossal wastage of funds and money spent on fruitless foreign tours, state banquets etc. and then debate the issue of low tax-to-GDP ratio.

Absentee landowners, which include the mighty military generals who have been allotted state lands under one pretext or the other during the last many decades, have been resisting proper personal taxation on their enormous income and wealth. 

Although in these columns, a detailed roadmap for reforming the existing tax system and raising taxes to the level of Rs. 20 trillion is presented, those fossilized bureaucrats sitting in Ministry of Finance and FBR, want “advice” and “assistance” from IMF and World Bank despite having miserably failed in the past to reform tax system.

The situation can aptly be described what great Urdu poet Mir Taqi Mir said in the following couplet:

Mir kya sada hein beemar howe jis key sabab,

usi attar key londey sey dawa letey hein

(What a simple soul is Mir; he seeks cure from the healer’s boy who is the cause of his ailment). 

It is tragic that in a country where billions of rupees are made in speculative transactions in real estate and shares, the tax-to-GDP ratio is pathetically low at 9.2 percent, and those who matter in the land are least bothered to tax the undocumented economy and counter benami transactions. The mighty sections of society are engaged in these transactions and FBR being their handmaid has no intention to tax them.

The definition of the term, ‘business’ given in section 2(10) the Income Tax Ordinance, 2001, covers “adventure in the nature of trade.” However, our tax machinery is sitting idle, causing enormous loss to the national exchequer by not bringing adventures in the nature of trade (speculative transactions) in real estate into tax ambit. The elected representatives have been giving undue tax exemption on gains arising on speculative transactions in shares and stocks.

The extending of extraordinary tax-free benefits to the powerful classes, failure to tap the actual tax potential, indulgence in wasteful expenditure and funding of inefficient public sector enterprises are continuously pushing the country to more and more borrowing - both internal and external.

A higher tax-to-GDP ratio in industrialized countries is primarily owed to the higher level of revenue from social security, payroll taxes, corporate taxes and taxes on domestic consumption, while taxes collected from international trade and non-tax revenue are lower. In contrast, in Pakistan the major portion of revenue comes from indirect taxes, particularly taxes on international trade and domestic consumption, while direct taxes have a pathetic share. 

The extending of extraordinary tax-free benefits to the powerful classes, failure to tap the actual tax potential, indulgence in wasteful expenditure and funding of inefficient public sector enterprises are continuously pushing the country to more and more borrowing - both internal and external. 

The unrelenting size of the fiscal deficit and rising quantum of debt are the major source of macroeconomic imbalances over the last many years. Making the things worse, the growth-retarding tax policy is playing havoc with an already stagnant economy. Sole stress on oppressive indirect taxes is not only widening the rich-poor divide, but has also failed to enable Pakistan to reduce even revenue deficit—we are not mobilizing enough to meet current expenditures.

The question is where does the fault lies? Even the World Bank-IMF funding and “guidance” has failed to bring desired results. Who is responsible for the prevailing pathetic state of affairs? Our debt burden has increased monstrously, the fiscal deficit is simply unmanageable, inflation is crushing the poor, taxes are evaded and avoided by the rich and whatsoever is collected is wasted by the rich and mighty. What a tragedy that the elites, not only evade taxes but also thrive at the taxpayers’ expense. They are the de facto beneficiaries of all the state’s resources, generated mainly by the suppressed land-less tillers and diligent industrial workers. 

Pakistan is not a poor country - the state’s kitty is empty because of colossal wastage of taxpayers’ money on unproductive expenses, including perks and perquisites of ruling elites, and non-exploitation of vital natural resources as well unwillingness of the rich to pay income tax. Absentee landowners, which include the mighty military generals who have been allotted state lands under one pretext or the other during the last many decades, have been resisting proper personal taxation on their enormous income and wealth. An unholy anti-people trio of the indomitable militro-judicial-civil complex, inefficient politicians and greedy businessmen—control and continue to enjoy at least 90% of the state’s resources, all while they contribute less than 1% towards national revenue collection.

The existing tax system is highly unjust. It protects the rich and mighty, who have a monopoly over economic resources.

The existing exploitative, rotten, regressive, ill-directed and unfair tax system is rapidly widening the existing divide between the rich and the poor. The lack of political will to tax the rich and the mighty, remains our dilemma—not scarcity of resources. Equity demands higher taxes from those who have higher income and wealth, but in Pakistan, since the first martial law, all fiscal policies have decreased tax burden on the rich and increased its incidence on the poor.

The existing tax system is highly unjust. It protects the rich and mighty, who have a monopoly over economic resources. Common people are paying an exorbitant sales tax of 18%, and an astonishing 35-40% on finished imported goods after mandatory value addition and income tax at source, on essential commodities, but the mighty sections of society such as big industrialists, landed classes, generals and bureaucrats are paying no wealth tax or income tax on their colossal assets and incomes.

For achieving the cherished goal of establishing an egalitarian state and self-reliant economy, heavy taxation of the privileged classes—ruling the country for the last seven decades, is the need of the hour. They are the real culprits, as they do not pay income tax and have amassed enormous wealth—many of them are beneficiaries of huge loans write-offs as well, but yet managed to be elected in general elections held on February 8, 2024. 

Many of them are guilty of plundering and wasting public money. The State has become so callous that the people living under the poverty line are subjected to exorbitant sales tax on items of daily use but the ultra-rich having billions are enjoying tax-free incomes.

Therefore, the issue of more taxes and improving tax-to-GDP ratio should not be discussed in isolation, but needs to be analysed from social justice point of view as well. We need to end inequalities and ensure fair and equitable of resources as part of a broader tax justice agenda.

Our present tax revenue potential, if the monstrous black economy is dealt with an iron hand, is not less than Rs. 30 trillion, provided that the existing tax base is made wider and equitable, the shadow economy is discouraged, tax machinery is completely overhauled and exemptions and concessions available to the privileged sections of society are withdrawn.

Pakistan’s tragedy is that things are always being done by people who are not eligible for that job, and lo and behold, now the SIFC is engaged in tax reforms. Military governments have historically made constitutional changes, and now military authorities are choosing to enact tax reforms in alliance with tax bureaucrats, with the latter having a proven track record of inefficiency, incompetence and corrupt practices.

Our present tax revenue potential, if the monstrous black economy is dealt with an iron hand, is not less than Rs. 30 trillion, provided that the existing tax base is made wider and equitable, the shadow economy is discouraged, tax machinery is completely overhauled and exemptions and concessions available to the privileged sections of society are withdrawn. To achieve these goals, we do not need any loan from the World Bank or other donors. If we take money from them, then we are bound to follow their conditionality, as beggars cannot be choosers.

Pakistan’s tax-to-GDP ratio at the FBR level alone can rise to 20%, if we bring 3.5 million ultra-rich individuals into the tax net, heavily tax speculative transactions in real estate, which will promote the construction industry as prices of land will come down, tax all speculative deals in the stock exchanges, which will induce genuine investment in companies, withdraw money whitening provisions like section 111(4) of the Income Tax Ordinance, 2001, withdraw all tax-free perquisites given to the militro-judicial-civil complex and public office holders, and move to confiscate untaxed assts.  

The writer, Advocate Supreme Court, is Adjunct Faculty at Lahore University of Management Sciences (LUMS), member Advisory Board and Visiting Senior Fellow of Pakistan Institute of Development Economics (PIDE)